Standing Committee A

[Sir John Butterfillin the Chair]
(Except clauses 13 to 15, 26, 61, 91 and 106, schedule 14 and new clauses relating to the effect of provisions of the Bill on section 18 of the Inheritance Tax Act 1984)

Clause 70

Restrictions on companies buying losses or gains

Amendment proposed [this day]: No. 106, page 57, line 10 [Vol I], at end insert—
‘184DA Sections 8, 184A and 184B: meaning of “main purpose”
For the purposes of sections 8, 184A and 184B “main purpose” means a purpose without which the underlying commercial transaction would not have occurred.'.—[Mr. Goodman.]

Question again proposed, That the amendmentbe made.

John Butterfill: I remind the Committee that with this we are discussing the following amendments:No. 107, page 60, line 4 [Vol I], at end insert—
‘(4A) At the end of section 176, add—
“(10) This section shall not apply to companies for disposals accruing after 5th December 2005.”'.
No. 108, page 60, line 6 [Vol I], leave out from ‘212)' to end of line 13 and add
‘subsections (8H) and (8I) shall cease to have effect.'.
No. 109, page 60 [Vol I], leave out lines 25 to 28.
No. 110, page 60, line 29 [Vol I], leave out from beginning to end of line 2 on page 61.

Dawn Primarolo: Good afternoon, Sir John, and welcome to this afternoon’s sitting. When we broke for lunch, I was responding to amendments Nos. 106 to 110, which were tabled by the hon. Member for Wycombe (Mr. Goodman). His points on amendment No. 107 related to section 176 of the Taxation of Chargeable Gains Act 1992, which covers some of the same ground as clause 69 in that it could be used to combat avoidance involving the artificial creation of losses. Section 176’s remit, however, is wider than just avoidance.
Section 176 covers purely commercial situations that would otherwise produce an unfair result for tax purposes. For example, if a company pays a distribution out of pre-acquisition profits prior to being sold, section 176 ensures that the correct amount of capital loss is recognised on the sale. To pay the dividend might well be a normal commercial judgment, but it is still appropriate to apply section 176. It has no purposive anti-avoidance test; rather, it is an objective test that is well understood and respected.
Like amendment No. 107, amendment No. 108 has nothing to do with the rest of the clause but touches on something else. It does not touch on the targeted anti-avoidance rules, but would remove a rule that applies only to life insurance companies with holdings in unit trusts and open-ended investment companies. Because they are charged tax on movements in the value of such holdings and not just on disposals, there is a unique relieving rule that allows them to carry back losses to the two previous periods. No other type of company is allowed to carry back capital losses. When an insurance company changes group, the current law prevents carry-back except where the losses arose on the assets that the company held before joining the new group. That is in line with the general thrust of the loss and gain buying rules.
The Bill will update legislative references and provide a minor relaxation of the restrictions on carry-back of losses. I am not sure what prompted amendment No. 108. The hon. Member for Wycombe said that it was probing and not directly relevant. On that basis, I do not accept it. However, because the point that he raises could none the less be advanced, I shall say to him that Her Majesty’s Revenue and Customs has recently issued a consultation document on taxation of life insurance companies. That is the right place to raise such issues regarding future intentions. I do not think that his point is necessarily relevant here.
Amendment No. 110 is strange. It would remove a transitional rule included in the Bill as a result of representations from companies and their advisers. It is strange to want to remove that. Subsections (9) and (10) are intended to provide additional relief for companies that have undertaken certain transactions prior to the pre-Budget report that do not involve gain or loss buying but that could have been subject to restrictions on their use of capital losses. They have been included because companies asked that the draft legislation include improved targeting in that specific area. The Government recognised that the original draft could be improved and responded accordingly. I cannot see any good reason why the amendment should stand, although I hope that the hon. Gentleman will accept my explanation. In effect, amendmentNo. 109 would remove from the scope of the clause any tax-driven purchase of a company that occurred before the pre-Budget report. If we were to accept that amendment, the subsection that it would remove would be unnecessary. However, as I do not believe that the amendment would have that effect, amendmentNo. 110 should also be rejected.
I hope the hon. Gentleman will accept those explanations of how the clause works and why this large group of amendments would not be necessary.

Stewart Hosie: I have listened carefully to the Paymaster General. Throughout her speech, she made continual reference to the fact that the provision is designed to tackle specific tax avoidance measures and schemes. However, as yet, I am not wholly convinced of that. She has said repeatedly that there was an HMRC informal procedure in which schemes, deals or trades could be checked to determine whether they were legal when companies were buying losses or whether they would fall foul of the provision. That runs the risk, I think, of companies being in a de facto starting position for almost every significant commercial transaction.
When a company may acquire another that has losses, the starting point will be to go to the HMRC to determine whether it will be a legitimate commercial transaction or whether it will fall foul of the new rules. That will run the risk of adding time delays, additional cost and uncertainty to the process of acquisition. That is important.
We should look at the various forms of purchase and the reasons for them in relation to amendment No.106. Companies may buy to extend their market share; as part of a pre-agreed growth strategy; to extend their geographic reach; to extend the development and production of sales capacity; or to gain new technology, expertise or skills. They may buy as part of a self-financed growth strategy or as part of planned use of investment cash from elsewhere—for example, from investors or one of the markets. They may buy or, indeed sell, as part of a takeover defence strategy or to position themselves after a disposal to take over another company. They may do so to avoid breaching monopoly and other fair trade rules. Companies may buy or sell to maximise shareholder value and fulfil their fiduciary duty. They may buy simply to diversify to protect themselves in the case of a business that had been too narrowly focused for the time being. They may also sell loss-making parts of the business to shore up the remainder or as part of a strategy to focus on core activity. They may sell in order to invest elsewhere.
Those companies that buy particularly to extend their geographic reach or increase turnover may well find that the best value they can achieve is to buy what are, at the moment, loss-making concerns. A judgment might be that the savings could, in the future, be made centrally through enhanced purchasing muscle and so on and so forth. They may feel that the name of the company and the reputation of its brand could turn what was a loss-making purchased company into a profit-making arm. All those decisions are legitimate and valid.
My worry is that the changes will add uncertainty, delay and cost to what should be a normal commercial transaction. I will concentrate on the consequences of the delay and uncertainty. They could be huge. If a company were unable to buy a loss-making concern, to put on muscle or perhaps reduce its value as a takeover defence mechanism and if it had to go to the HMRC to identify in advance if that was a legitimate transaction, it could be extremely worrying. Companies that sell may find that there is no longer a market there if they are trying to divest themselves of a loss-making arm. If there is a delay in doing that and if the cash is not brought in quickly, they may end up carrying costs that they did not anticipate, which may put the rest of the business at risk.
I recognise the Paymaster General’s earlier concerns, and amendment No. 106 seems to suggest that if companies purchased a loss in any of the ways I cited and part of the transaction was defined by the HMRC as legitimate, they could mask a purchase of the loss for the purpose of tax avoidance, which she referred to earlier. I am not convinced that I would vote for the amendment if it were pressed to a vote, but I would like her to address these legitimate concerns. If we are not satisfied today, we may have to return to clause 70 and related clauses at a later stage.

Dawn Primarolo: To help the hon. Gentleman, we are dealing with a series of clauses: clauses 69, 70 and 71. I referred to the informal clearance procedure when we discussed amendments Nos. 105 and 101. Those were grouped under clause 69, but amendment No. 101 is relevant. It is the same type of amendment becauseit would include a statutory clearance procedure in clause 71. It was included in that group because all the amendments dealt with the same subject matter.
I agree absolutely with the hon. Gentleman’s general points, which I also made, on why a statutory clearance procedure was not desirable for the reasons he gave. Such a procedure was unsuitable for clause 69 because that clause is specific, clear and targeted, and it is accepted as such. The informal procedure I referred to in response to amendment No. 101 relates to clause 71. I went on to say that despite the fact that it was an anti-avoidance measure, it was far more complex than that. Additional points were necessary, which is why I raised the informal clearance procedure, the guidance and other supports that the HMRC would put in place for companies that sought that certainty. I concur with the hon. Gentleman regarding the undesirability of statutory clearance requirements in these clauses.
The hon. Gentleman’s second point relates to clause 70, which introduces new provisions to deal with capital losses and capital gain buying. Again, it only applies when the main purpose—or one of the main purposes—of the arrangements in place was obtaining a tax advantage. Before the Committee started, you and I reflected on this matter, Sir John, and on the existing legislation that already dealt with it, so it is not a new subject or an exclusion that companies might not be aware of—they are aware of it. The legislation was designed to stop companies exploiting losses in the ways that we have discussed.
Unfortunately, ways have been found around the legislation, which has been in place for quite a long time. It pre-dates this Government. Clause 70 will repeal the old bits of the legislation—the gain buying rules that have been repealed—and includes the anti-avoidance measures. It leaves the old loss-buying rules, because they still have a purpose. That was the point of the exchange between myself and the hon. Member for Wycombe about the amendments that he tabled.
All the fears that the hon. Member for Dundee, East (Stewart Hosie) suggested would not apply at this point. There is not an informal clearance requirement and the clause is straightforward. Therefore, I can confidently reassure him that some of his examples would not occur. I hope that that clarifies things, because the three clauses interact.

Paul Goodman: It is good to see you in the Chair, Sir John. If I may interact withthe Paymaster General about her response to the amendments as follows—

Dawn Primarolo: How interesting.

Paul Goodman: I am gratified that the Paymaster General says it is interesting, because I was not convinced that she would necessarily think that was the case—[Interruption.] At last, a Government Back Bencher is paying even closer attention to the detail of the Committee’s procedure than they have to date. They will turn with interest to what the Paymaster General said about amendment No. 108. What she said about a consultation in relation to the point that I raised about life assurance was welcome, because it was put to me that the rule changes could hurt policyholders and deter life assurance companies from commercial mergers. If we are talking about life, that issue will be relevant to the consultation.
On amendment No. 106, where we have a stab at writing into law a definition of what the “main purpose” of a company is when that main purpose is to avoid paying tax, the Paymaster General made the point that the definition would be a narrow one. I accept that, so I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 70 ordered to stand part of the Bill.

Clause 71

Other avoidance involving losses accruing to companies

John Butterfill: I have been advised that the hon. Member who was to move amendment No. 99 and speak to the group of amendments would prefer notto move that amendment or speak to amendmentsNos. 111 and 102. He simply wishes to move amendmentNo. 100. Is that correct?

Paul Goodman: That is correct, Sir John.
I beg to move amendment No. 100, in page 61[Vol I], leave out lines 31 to 44.
The reason for that change is as follows: as the Committee will be aware from listening to the Paymaster General’s response to the amendments that were tabled to clause 69, clauses 69 and 71 are closely related. In the debate on clause 69 she dealt with the arguments in the three amendments that I do not wish to discuss.
However, amendment No. 100 is discrete. The lines it proposes to delete refer to an arrangement of notices. It is a probing amendment, seeking to explore the regime of notices that the clause would write into the Bill. The clause does not impose a tax system that Her Majesty’s Revenue and Customs may challenge in the formal manner if it disagrees with the self-assessment. It would instead allow HMRC to issue a notice, which arguably represents issuing a notice by diktat. We should be grateful to hear a reason for the measure, particularly because the tax planning that would trigger the issue of the notice would probably have to be disclosed to HMRC under the disclosure of tax avoidance scheme rules, which are being extended in their remit. So HMRC should not be ignorant of the planning undertaken. There also seems to be nothing in the clause that enables a company to appeal against such a notice. It could be argued that that gives tothe Executive considerable powers that they shouldnot have.

Dawn Primarolo: I shall refer to the question of issuing a notice, which amendment No. 100 covers. Issuing of notices is a general part of the disclosure requirement regime. HMRC would issue the notice when it believed that the conditions of the clause were met; however, companies need not be concerned by the provisions unless they receive a notice. That is the first step. The notice would be a possibility if conditions were met. Obviously, HMRC must be consistent when issuing notices, and such issuing must be based on cases to which it reasonably believes that the conditions of the legislation apply. The conditions requirement means the exercise of judgment, but that is inevitable for what is a purposive test. There is nothing unusual in that, and such judgment is called for in many other areas of tax law.
HMRC has also issued guidance, to which I referred when we discussed amendment No. 101 and clause 69. HMRC has issued guidance on how it will exercise judgment in relation to the legislation. We were discussing the informal clearance procedure, and HMRC has also offered clearance on an either pre or post-transaction basis. Clearly, however, if a company takes its own view during its self-assessment, and ultimately disagrees with the decision, it will be referred to a special commissioner for ruling before going through the normal processes. I am not sure that I made this point this morning, so I should add that having given that informal clearance, HMRC will be bound by it—as long as all relevant facts about the arrangement had been disclosed in the first place. I hope that that explains the procedures. The hon. Member for Wycombe asked, if a company nevertheless disagrees, can it challenge? The answer is yes.

Paul Goodman: I think that the Paymaster General is saying that, in effect, there is an appeal system after the notice is issued. That being so, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 71 ordered to stand part of the Bill.

Clauses 72 to 74 ordered to stand part of the Bill.

Clause 75

Interest relief: film partnership

Question proposed, That the clause stand part ofthe Bill.

Theresa Villiers: Clause 75 deals with film tax partnerships, and the Opposition broadly support it. Film tax issues have already been discussed by the Committee at length, but the avoidance scheme on which the clause focuses is one of the latest of many that have sought to exploit loopholes in film tax laws. As I stated in the debate on chapter 3, we have reservations about certain aspects of the proposed film tax structure, but we believe that the Government are right to close the loopholes, and we agree that the complex system of sale and leaseback contracts should not continue, because it is not yielding sufficient value for money for the taxpayer.
It seems strange to remark on specific legislation concerning this particular scheme, given that the regime that makes such schemes possible is about to be abolished. I have some sympathy with the position of the Law Society, which has questioned whether
“it is worth introducing a provision of such complexity and narrowness on the statute book, particularly when film tax reliefs are being refocused”.
However, I acknowledge that the particular scheme that we are debating has long been a target for the Revenue—even from before the decision to opt for wholesale film tax revision, although I have never understood why the Government want to focus on it so much. For some years, the plain vanilla sale of leasebacks had been tolerated by the Revenue if it resulted only in a deferral of tax. However, the structure we are discussing goes further—it seeks to achieve tax reduction by converting taxable income into permanently tax-free income. The scheme has an opaque and complex structure that involves both a film partnership and an investment partnership.
The clause restricts the amount of tax relief on interest borne by loans whose purpose is the funding of investment in a film partnership. Instead of 100 per cent. deduction being permitted, a film partner will be able to deduct only 40 per cent. of paid interest, which will ensure that at least some film income ends up being taxable. The Revenue believes that the 40 per cent. figure will leave the investor in a similar tax position to that for a plain vanilla sale and leaseback structure, in which benefits are only deferred. However, the Law Society pointed out that the 40 per cent. figure seems fairly arbitrary, so will the Paymaster General indicate how the Treasury made that calculation? Other than on that point, the Opposition have no objection to the stand part motion.

Dawn Primarolo: I agree with the hon. Lady that the need for the provision is regrettable. That is particularly so given that the Bill also contains tax credit provisions that she has acknowledged are better suited in directing money to those engaged in production, rather than to high-value individuals who are not connected to production and who are simply looking for a tax-saving scheme.
The change was needed because the schemes were particularly aggressive: sale and leaseback occurred over a 15-year period and it was necessary to ensure that tax was paid over the rest of the period. Her Majesty’s Revenue and Customs became aware that the schemes were being marketed aggressively and the likely exposure, had we not taken steps, would have been substantial. I am sure that the hon. Member for Chipping Barnet (Mrs. Villiers) can imagine my delight in finding that I had to have yet another arrangement under the Finance Bill in respect of films. It has been challenging for all hon. Members who want to assist particular technological abilities and the developments in the film industry for such matters to be based in the United Kingdom where we have great skills. There also comes a point when we must question for what the tax relief is providing.
As for the question posed by the Law Society, 40 per cent. is not an arbitrary figure. HMRC approached the matter by undertaking a detailed study of standard sale and leaseback structures. It gave it a reasonable approximation of the position that investors would be in had they invested in such structures in a straightforward way. The figure of 40 per cent. was therefore chosen as a proportionate response to that particular type of aggressive tax plan. It was simply trying to squeeze out aggressive tax planning. Such matters will never be an exact science, but it was an attempt to deal with the avoidance while not hitting other forms of sale and leaseback. I hope that hon. Members are satisfied by my clarification of matters.

Question put and agreed to.

Clause 75 ordered to stand part of the Bill.

Clause 76 ordered to stand part of the Bill.

Schedule 6

Avoidance involving financial arrangements

Amendment proposed: No. 66, in page 185, line 5[Vol I], leave out sub-paragraph (1) and insert—
‘(1) After section 85B of FA 1996 (amounts recognised in determining company's profit or loss) insert—
“85C Amounts not fully recognised for accounting purposes
(1) This section applies if—
(a) a company is, or is treated as being, a party to a creditor relationship in any period,
(b) an amount is not fully recognised for the period in respect of the creditor relationship,
(c) the company is, or is treated as being, a party to a debtor relationship in the period or has at any time issued share capital which falls to be treated for accounting purposes as a liability (a “relevant accounting liability”) for the period,
(d) an amount is not fully recognised for the period in respect of the debtor relationship or relevant accounting liability, and
(e) the amounts are not fully recognised as mentioned in paragraphs (b) and (d) as a result of the application of generally accepted accounting practice in relation to the creditor relationship and the debtor relationship or relevant accounting liability.
(2) For the purposes of subsection (1) an amount is not fully recognised for the period in respect of any loan relationship or relevant accounting liability of the company if—
(a) no amount in respect of the relationship or liability is recognised in determining its profit or loss for the period, or
(b) an amount in respect of only part of the relationship or liability is recognised in determining its profit or loss for the period.
(3) In determining the credits and debits to be brought into account by the company in respect of the creditor relationship for the period for the purposes of this Chapter, the applicable assumption (see subsection (6)) must be made.
(4) In any case where the condition in subsection (1)(c) is met by reference to a debtor relationship of the company, in determining the credits and debits to be brought into account by the company in respect of that relationship for the period for the purposes of this Chapter, the applicable assumption must be made.
(5) But the amount of any debits to be brought into account by the company for any period for the purposes of this Chapter as a result of subsection (4) must not exceed the amount of any credits to be brought into account by the company for the period as a result of subsection (3).
(6) For the purposes of this section, in relation to any loan relationship, the applicable assumption is the assumption that an amount in respect of the whole of the relationship is recognised in determining the company's profit or loss for the period.
(7) In any case where—
(a) apart from this section any credits or debits are brought into account by the company in respect of any loan relationship for the period for the purposes of this Chapter, and
(b) the relationship is one to which this section applies,
the credits and debits to be so brought into account as a result of this section must be determined on the same basis of accounting on which the credits or debits mentioned in paragraph (a) were determined.
(8) In any other case, the credits and debits to be so brought into account as a result of this section must be determined on the amortised cost basis of accounting.”.'.—[Dawn Primarolo.]

John Butterfill: With this it will be convenient to discuss Government amendments Nos. 67 to 70.

Mark Hoban: I wish to raise some worries that the Chartered Institute of Taxation had about the original paragraph 6 that the amendment would delete and I wish to clarify whether those worries have been addressed by the amendments tabled by the Paymaster General. The institute is worried about the way in which the measures relate to sub-participations in loans and how they are dealt with. For the sake of clarity, I shall set out how matters work. What usually happens in respect of a funded sub-participation is that the originator would derecognise part of its assets for accounting purposes. Let us suppose that a loan of £100 is originated, of which 40 per cent. is sub-participated. The originator only shows a loan of £60 on its balance sheet, the profit and loss account only shows income of £60 and nothing is recorded for the remaining 40 per cent. asset or the 40 per cent. liability under the sub-participation agreement.
The Chartered Institute of Taxation believed that, under the original paragraph 6, the proposed new section 85C of the Finance Act 1996 will now require an originator to recognise income on the full £100 of the loan asset. When the sub-participation agreement is a loan relationship under proposed new section 85C, the originator will, in addition to taxing the debits and credits on the whole £100 of the loan asset, be able to recognise the debits and credits on the loan liability of £40, so the net result is that it still shows an asset of£60 and it shows the income of £60 on its profit and loss account.
The Chartered Institute of Taxation’s worry about the matter and the Government’s original proposals was that, when the sub-participation agreement is not a loan relationship under proposed new section 85C, the originator seems to be taxed on the income of£100 from the loan asset, but there is no mechanism to give relief to the amounts paid away on the sub-participation agreement. Therefore, it would be taxed on £100 in its profit and loss account, but it would have no relief on the interest it pays on the 40 per cent. ithas given away—as it were—to someone involvedin sub-participation, unless of course the “fairly represent” provision in section 84 of the FinanceAct 1996 overrides that position. I should be grateful if the Paymaster General would say whether she believes that the “fairly represent” provision in section 84 does override the treatment of the sub-participation where there is not a loan relationship in accordance with proposed new section 85C.
There are a couple of other issues to do with this relationship that I ought to go through. Under proposed new section 85C, there are potential consequences for originators in relation to what might happen where the underlying asset is impaired. Proposed new section 85C requires the originator to recognise the entire loss. The originator would also be entitled to recognise the gain under the sub-participation agreement. There should be no impact overall in respect of this, unless one of two conditions are met. Either the section 209 “results dependent” provision of the Income and Corporation Taxes Act 1988 applies to deny interest deductions, or the sub-participant is a connected party. Section 209
“could apply wherever the sub-participation counterparty is not within charge to corporation tax (eg neither a UK bank nor a UK branch)”
and that would then deny the interest deductions required to balance out the interest of £100 on this sub-participation.

Rob Marris: I am perhaps becoming forgetful, but could the hon. Gentleman remind me what section 209 of the Income and Corporation Taxes Act 1988 actually says?

Mark Hoban: I am not going to go into that because it distracts from our purpose. A problem I have detected with our adumbrations is that sometimes too much detail gets in the way of the thrust. It is important for those outside this debate to have their minds focused on the essence of the argument, rather than be distracted by the hon. Member for Wolverhampton, South-West (Rob Marris) down the highways and byways of the voluminous legislation that underpins our proceedings today.
That deals with section 209. [Interruption.] Letme come back to the second issue, where the sub-participation is to a connected party. There are some issues around the timing of interest payments and whether that is a timing difference, and there are some issues around transfer payments, but in the view of the Chartered Institute of Taxation that is neither here nor there. However, there is a concern that where a connected party is involved there may be no relief available for impairments due to the denial of connected party impairments. Its belief is that in the original drafting this appears to be unintentional; I would be grateful if the Paymaster General were to confirm that that is indeed the case—or that her Government amendments Nos. 66 to 70 address this concern.

David Gauke: In a similar spirit, may I just raise a couple of points that the Law Society has highlighted in respect of schedule 6, and ask whether the new wording introduced by the Paymaster General will address those concerns? The first relates to basic principles of loan relationship legislation. I assure the House that the Law Society guidance was not produced by my wife, although it was produced by my former law firm—I stress the “former”, so I have no financial interest to declare. According to the Law Society brief,
“The general rule is that the items that are brought into account and the timing of any tax charge or relief are determined in accordance with the company’s accounting treatment”,
but the view is that the original wording of schedule 6 undermined that principle. The Law Society states:
“The effect is that once a company has determined the relevant profits and losses on its loan relationships that are reflected in its accounts, it will have to consider separately whether those credits and debits ‘fairly represent’ its profits and losses”.
The Law Society’s concern is about the degree of uncertainty, because there does not appear to be any guidance on how a firm should make that assessment.
My second point is similar to one mentioned by my hon. Friend the Member for Fareham (Mr. Hoban). It is about whether the new provision will catch all forms of intra-group lending. The Law Society does not believe that that is the intention, but perhaps clarification would be helpful.

John Butterfill: I hope that the Paymaster General will not be tempted to respond to the question asked by the hon. Member for Wolverhampton, South-West, because I have just checked, and the relevant section covers no fewer than five pages.

Dawn Primarolo: Thank you, Sir John; I shall be brief, then. First, as the hon. Member for Fareham (Mr. Hoban) identifies, amendment No. 66 relates to a measure dealing with avoidance schemes that rely on accounting rules to cause profits on loan relationships to be de-recognised, and so fall out of tax charges. He is quite right that concern was expressed about the original drafting, which would have meant that the measure applied to certain types of normal, commercial transactions such as hedging arrangements and sub-participations entered into by banks. The Government listened very carefully to representations and accepted that the original drafting may have gone too far. Amendment No. 66 has effectively rewritten the measure so that it is more narrowly focused on the avoidance scheme at which it is aimed, and ensures that it does not catch commercial activities.
As for the hon. Gentleman’s two points on certain banking sub-participations, the measure will not affect the banking sub-participation market. The complaint was in connection with the application of the connected party rules on impairment losses, but the measure will not make banks and their associates any worse off. The hon. Gentleman made a further point about connected party bad debt rules. The anti-avoidance measure in the Bill does not actually deal with that, and if there is a problem, this is not the place in the Bill in which to try to solve it. I say to the hon. Gentleman and those who read our deliberations that if banks consider there to be a serious problem on that issue, I will ensure that my officials discuss those issues with the banking industry very quickly. I do not believe that the matter is specifically connected to the clause, but if that subject is being raised as an issue, the industry needs to come forward formally with it in discussions. We would be happy to hear what it has to say.
Amendments Nos. 67 to 70 make small but important changes that modify the shares as debts rules introduced last year. I think that they are straightforward, and perhaps I do not need to reflect on them. The hon. Member for South-West Hertfordshire (Mr. Gauke) asked about loan relationships, and I touched on that under contracts.
As I said, having listened carefully, the Government are undertaking in the amendments to put beyond doubt what they believe the position always has been in respect of this matter. Most commentators now accept it, but a few have argued that tax computational laws, which rely on accounting recognition of profits, override the basic requirement that amounts brought in to charge for tax are those that fairly represent profits and gains arising to companies.
The measure does not undermine the principles of the two regimes—that is the important message. In fact, it supports them by basing the tax measure of income on normal commercial accounting, which we would expect fairly to represent accruals profits and gains arising to the company, so there is no need for uncertainty. That is the long answer. Basically, we listened to the points that were made and amended the legislation accordingly.
There seems to be one further point in respect of connected party bad debt rules, which was not part of the submissions from others. It would not be dealt with in the schedule anyway, as it is not relevant. However, as I said, if there are particular issues outstanding, I would be more than happy to ensure that they are passed on, and to arrange for officials to meet the industry to discuss them.

Amendment agreed to.

Amendments made: No. 67, in page 187, line 42[Vol I], leave out ‘relevant'.
No. 68, in page 188 [Vol I], leave out lines 6 and 7.
No. 69, in page 188, line 18 [Vol I], at end insert—
‘(5A) The amendments made by sub-paragraphs (2) and(3) have effect in relation to any share held by a company on or after 12th May 2006 in any case where—
(a) the share is redeemable for the purposes of section 91D of FA 1996 as a result of any arrangements mentioned in subsection (2)(b) of that section (as substituted by sub-paragraph (2)), and
(b) the arrangements were entered into after the company acquired the share.
(5B) But in that case, in relation to an accounting period beginning before 12th May 2006, amounts are to be brought into account for the purposes of Chapter 2 of Part 4 of FA 1996 as a result of those amendments only if the amounts relate to any time on or after that date.'.
No. 70, in page 188, line 19 [Vol I], at beginning insert ‘In any other case,'.—[Dawn Primarolo.]

Question proposed,That this schedule, as amended, be the Sixth schedule to the Bill.

Mark Hoban: I wish to raise some issues about schedule 6 that have been brought to my attention, principally by the Law Society. The first is a change introduced in the Budget and proposed in paragraph 4 to the rules concerning mandatory convertible securities and the deemed disposal of those securities on 2 March 2006. There is concern that intra-group reorganisations or transfers might lead to a tax charge being payable, despite the fact that the group had not sold the security.
I shall go into more detail. As the Bill stands, a company that holds the benefit of a mandatory convertible security on 22 March 2006 is treated as making the disposable security at its market value on that date. The resulting gain or loss is brought into charge to tax when the company ceases to hold the security. The provision would bring the deferred gain or loss into charge to tax on any disposal in paragraph 4(6)—even on an intra-group transfer or reorganisation, when a company, or group of which it is a member, has not realised any economic benefit from the disposal.
Will the Paymaster General confirm that in such circumstances the deferred gain or loss would actually be deferred, and that no tax would be payable until there was a real economic disposal of the mandatory convertible security? I understand that such an approach would be consistent with that adopted for money debts that were chargeable assets when the loan relationship rules under the Finance Act 1996 were introduced. That is my first point.
Paragraph 5 is the subject of my second point, on which my hon. Friend the Member for South-West Hertfordshire may have touched during the debate on Government amendment No. 66. Again, the concern is that the paragraph, which looks relatively innocuous, states that
“Section 85A of FA 1996...is amended as follows...In subsection (1) (amounts to be brought into account are those recognised in determining company’s profit or loss) after “Subject to the provisions of this Chapter” insert “(including, in particular, section 84(1))”.
The Paymaster General touched on the issue during her response on the last group of amendments. The concern is that the paragraph seems to change the basis on which interest and other aspects of the loan relationship are treated. Historically, they have been treated in accordance with accounting principles. There is concern that paragraph 5 changes that so that when companies have drawn up their accounts in line with generally accepted UK accounting practice, they have to work out what “fairly represent” means, without having the guidance to enable them to do so. There is concern that if there is such a change, more guidance ought to be provided to taxpayers to help them understand what “fairly represent” means in the circumstances and why it overrides general UK accounting practice.
My third point relates to paragraph 10 of the schedule and to intra-group lending. I think that my hon. Friend touched on the issue earlier; perhaps the Paymaster General does not need to refer to that point, but I should be grateful for her thoughts on the treatment of deemed disposals on mandatory convertible securities.

Dawn Primarolo: The transitional rules work in a fair way. When a mandatory convertible is first brought within the loans relationship regime, a capital gain is calculated by reference to fair value at that time. However, that gain is not taxed until the company disposes of the convertible. Any amount of tax under the loan relationship rules cannot be brought into accounting in any other way, so it cannot be included in the working out of capital gain; it is not clear how it is thought that there would be a problem.
As most mandatory convertibles appear to be used for tax avoidance purposes, there is unlikely to be any commercial reason why they should need to be subject to a group reorganisation and there is no reason for a more generous regime than is in the Bill. I dealt with the hon. Gentleman’s second point in answering his hon. Friend the hon. Member for South-West Hertfordshire. It is the Government’s view that the measures before us are a fair representation of what we always believed was the case. However, some commentators argued to the contrary, so the change will put the matter beyond doubt. The measures will reassert the Government’s view on how the rules should work.
I remind the hon. Member for Fareham that we are trying to deal with avoidance. A great deal of care has been taken to consider specifically how to target and deter avoidance without causing problems for legitimate commercial relationships. I hope that he will accept that.

Question put and agreed to.

Schedule 6, as amended, agreed to.

Clause 77 ordered to stand part of the Bill.

Clause 78

Controlled foreign companies and treaty non-resident companies

Question proposed, That the clause stand part ofthe Bill.

Dawn Primarolo: I hope that the Committee will bear with me as I introduce clause 78. It is important that I put some points on the record to assist everybody using our deliberations and the Government’s clarifications.
Clause 78 deals with controlled foreign company legislation and is designed to prevent UK companies from diverting profits to low-tax regimes. It is important to remember that the only companies that face a charge under CFC legislation are those that divert profits from the UK to avoid UK tax. Unfortunately, CFC legislation is constantly under attack from those who seek to avoid Parliament’s intentions. This Government and previous Governments have had to add additional anti-avoidance rules to ensure that it remains fit for purpose.
Clause 78 will block a loophole in one such piece of anti-avoidance legislation, section 90 of the Finance Act 2002. The particular mischief that concerned the Government then and now was that companies can artificially migrate to another country simply to avoid the effect of the CFC rules by using the provisions of a double taxation treaty.
It was widely accepted at the time that such migrations might have become possible as a consequence of the exemption from corporation tax of companies’ chargeable gains from substantial shareholdings, which came into effect on 1 April 2002. The exemption was welcomed by business, which was also fully involved in developing section 90. Companies that migrated before 1 April 2002 were excluded from section 90, not least because they did not have the benefit of the substantial shareholdings exemption when they migrated.
The Government have since become aware that some excluded companies are being used in tax avoidance schemes, and clause 78 seeks to counter such schemes. We have targeted the clause as tightly as possible to avoid leaving open unacceptable risks of continued avoidance on one hand and, on the other, to continue to exclude companies not involved in tax avoidance. The clause does so by focusing mainly on the type of company used in marketed tax avoidance schemes.
Condition A focuses on companies that have never owned any subsidiaries and are available to use as special purpose vehicles in avoidance schemes. If we left it there, we suspect that, such is the ingenuity of tax planners’ imaginations, it would not be long before companies that happened to own a subsidiary or two were used instead, so condition B aims to forestall all such manipulation.
Condition B is designed specifically not to catch migrated companies that are already the parent of multinational groups and continue to act as the parent of the same group. Such companies are outside the scope of the clause and will not be affected by it when the group makes acquisitions, including sizeable acquisitions, within its own sector in the normal course of its business. Any company that is in doubt as to how the clause will apply should seek clarification from HMRC, but I hope that I have put clearly on the record what is outside the scope of the clause and that no further clarification will be required.
The changes introduced in the clause ensure that from 22 March 2006 the position is returned to that intended in 2002. The clause will prevent tax avoidance and ensure greater consistency between companies that became non-resident at any date. I commend the clause to the Committee.

David Gauke: I am grateful for the Paymaster General’s comments and particularly her comment that the controlled foreign companies law is constantly under attack from those seeking to undermine Parliament’s will. She will be aware of an attack on that law in the current Cadbury Schweppes case, which is proceeding through the European Court of Justice. The Advocate-General has already determined against the Government. I merely ask whether anything in the clause anticipates a judgment in that case and, if not, what is the likelihood of the legislation having to be reformed next year or the year after in consequence of an adverse judgment from the ECJ. Has the Treasury reached an estimate of the likely cost of the Cadbury Schweppes case if the ECJ finds against the Government?

John Butterfill: Order. I do not think an estimate of the cost of the Cadbury Schweppes case is relevant to the clause.

David Gauke: I am grateful, Sir John. I withdraw that question and have no further comments.

Philip Dunne: I was interested to note that the Paymaster General referred specifically to acquisitions abroad within the sector of operation of the UK resident company or parent entity. I shall be grateful if she could clarify whether she is ruling out international diversification as a means of tax avoidance when there may be a bona fide reason for a UK-based company to acquire a company in a different sector but with some similarities. Is that intended to be caught by the measure?

Mark Hoban: I shall briefly make one or two points. I am grateful to the Paymaster General for her clarification of the clause. I know that people outside the House will appreciate her comments and clarity. I want to be clear about one point. She suggested that companies should seek advice before entering into one of those transactions, but I was not clear whether that was a form of pre-clearance mechanism or a form of guidance that they could receive from the HMRC prior to entering into a transaction. I would be grateful for clarification from her on that.
The Paymaster General referred to examples, and although I do not wish to ask for specific examples, will she state how many companies migrated offshore prior to 1 April 2002? That will tell us whether she is addressing a small problem or trying to close a large loophole.
As my hon. Friend the Member for South-West Hertfordshire said, we are conscious of the issue relating to the threat posed to CFC legislation by European Court judgments. He referred to the Cadbury Schweppes case. There appears potentially to be an issue when the UK-incorporated company has migrated to within the European economic area: the loophole that the Paymaster General is trying to plug will not be plugged if the judgment goes against the UK Government, whereas companies outside the EEA will find the loophole being closed down. I would be grateful if she would address the issues relating to the ECJ and its thoughts on the CFC legislation. To what extent can protection be gained to prevent more companies from trying to avoid tax by locating outside the EEA?

Dawn Primarolo: I shall deal first with the question on the Advocate-General’s opinion. As the hon. Gentleman knows better than I do, it is an opinion; it advises the Court and it is not a final judgment. I am sure that he would not expect me to go any further. He will have seen from the Advocate-General’s opinion that CFC rules were considered to be compatible with the treaty freedoms and that compliance with such regimes does not represent, in the Advocate-General’s view, an unacceptable burden on companies. However, I have made it clear that that is his opinion and it would be unwise for me to go any further until we have a judgment from the Court.
On the specific points, I do not have a figure in respect of migrated companies—I am unsure whether one exists. It would be substantial, and we can see that in the flows. I wonder whether the hon. Gentleman would find it acceptable for me to write to him, members of the Committee and to you, Sir John, to outline the scope of the problem. We believed that it was not insignificant and a potentially difficult issue.
The hon. Gentleman made a point about clearance. I was not suggesting a statutory clearance procedure in my opening remarks on the clause: I was saying exactly what we thought was outside. If companies wished still to seek clarification from the HMRC on a case in this area, they could do so and the HMRC would consider itself bound, as is normal, by what it then advised.
Let me turn to the other questions. Bona fide acquisitions are not caught. Diversifications are not ruled out, but they can be complex. The hon. Member for Fareham will understand from my opening remarks the specific points that we are trying to address. I do not want this to be a cumbersome process, because it is no good for the companies either. They are taking decisions on this matter and need to do so at a relatively fast rate. However, if a company were in any doubt, the offer relating to the seeking of clearance and advice in the informal procedures, to which I referred, would be open and the same points would stand with regard to the advice given.
We have tried to return the legislation to the 2002 intent. It is difficult, given the ingenuity of tax planners, but at every opportunity we must recognise legitimate activities and place them outside the scope of the clause. When that is not clearly done, I suggest that companies speak directly to the HMRC to get its response to their particular case.

Question put and agreed to.

Clause 78 ordered to stand part of the Bill.

Clause 79 ordered to stand part of the Bill.

Schedule 7

Transfer of assets abroad

Amendments made: No. 73, page 196, line 31 [Vol I], leave out
‘the transfer and any associated operations'
and insert
‘such of the relevant transactions as were'.
No. 74, page 196, line 42 [Vol I], leave out from first ‘to' to second ‘the' in line 43 and insert
‘relevant transactions by reference to which'.
No. 75, page 197, line 1 [Vol I], leave out ‘other associated operations' and insert
‘associated operations not falling within paragraph (a) above'.
No. 76, page 197, line 32 [Vol I], at end insert—
‘ “relevant transactions” means—
(a) the transfer, and
(b) any associated operations.'.—[Dawn Primarolo.]

Question proposed, That this schedule, as amended, be the Seventh schedule to the Bill.

George Young: I just wanted to press the Paymaster General on what appears in schedule 7 regarding conditions A and B.
The schedule deals with the transfer of assets abroad. I have no time for those who transfer their assets abroad with a view to avoiding tax and I welcome the initiatives that the Government are taking in the Bill to stop that practice. However, there are legitimate reasons why assets might be transferred abroad—the establishment of a business, for example. The bit that caught my eye is in paragraph 3, where we come across conditions A and B. The provision is referred to in the explanatory notes as a revised purpose test, designed to discover the motive behind the transaction. I would be grateful if the Paymaster General would let me know whether the conditions appear in other tests of tax avoidance.
As I understand it, if there is a dispute between the Revenue and an individual as to whether a certain activity is taxable, it goes before the courts at the end of the day, and they would consider all the circumstances of the case and come down on one side or the other. If one goes down the condition A and condition B route, the taxpayer would not just have to show that, on balance, his interpretation was correct, but that the interpretation the Inland Revenue had put on it was unreasonable. It would be interesting if the Revenue planned to introduce this test in schedule 7, but extended it broadly to apply to other cases in which there was a dispute between the individual and the Revenue. If it did, the terms of trade between the Revenue and the individual would be tilted towards the Revenue.
I have some questions for the Paymaster General when she winds up the debate. Is there any precedent for the conditions; why do not they apply, as I understand they do not, in other tests of tax avoidance; and are they the beginning of a series of new tests designed to shift the balance away from the individual and towards the Revenue?

Mark Hoban: I shall raise several concerns, particularly from the Law Society, about the operation of schedule 7. Some of them touch on the points that my right hon. Friend the Member for North-West Hampshire (Sir George Young) made. The Institute of Chartered Accountants in England and Wales has also expressed some concerns about the operation of schedule 7.
Schedule 7 amends the exemptions for bona fide transactions from sections 739 and 740 of the Income and Corporation Taxes Act 1988. However, representations from the Law Society suggest that in several respects the schedule goes too far, narrowing unnecessarily the scope of the exemption and imputing on to the taxpayer the motives of the tax adviser.
My right hon. Friend referred to the two tests—conditions A and B. The Institute of Chartered Accountants in England and Wales would welcome some guidance on the circumstances in which HM Revenue andCustoms believes that condition A would be satisfied. Paragraph 60 of the consultation document, “Transfer of Assets Abroad—Technical Notes on Draft Clause”, sets out the Revenue’s view that the new provisions will require all relevant circumstances of the case to be considered, including the
“actual objective outcome of the transactions”.
The purpose of the amendments is to move away from a subjective test of what happens when assets are transferred abroad, to a more objective test of the motives behind it.
If the objective outcome of the transactions is no reduction in the amount of UK tax payable, arguably there will be no need for the Revenue to invokethe provisions in section 739 of the 1988 Act, thus rendering the exemption of proposed new section 741A redundant. The ICAEW requests clarification about whether the Revenue envisages any scenarios in which the objective outcome of the transaction results inthe reduction of UK tax, but the exemption under proposed new section 741A(1)(a) is still allowed, by virtue of condition A being satisfied.
Condition B is a broader test of the transactions. It requires all transactions to be commercially valid, and requires that the steps in the transaction are no more than incidentally designed to avoid the liability for tax. Subsections (5) and (6) of this schedule then give further details of the definition of commercial transactions.
The Law Society believes that transactions by individuals are unlikely to benefit from the exemption in condition B. In a clear example, it shows that if a transferor transfers assets into a trust for investment, the transfer will not be at arm’s length, and it will therefore fall outside the exemption. Indeed, that would be true if an individual invested directly into an overseas fund, since although the fund would meet the conditions of subsection (5), the personal investor would not.
Furthermore, the Law Society is concerned that subsection (6) is overly focused on the structure of the transaction. It provides that
“the making and managing of investments...is not a trade or business except to the extent that—
(a) the person by whom it is done, and
(b) the person for whom it is done,
are independent”.
For that purpose, independent means that the persons concerned are not connected within the meaning of section 839 of the 1988 Act. The provision puts to one side whether transactions are done on an arm’s length basis, and it focuses on whether the people involved are connected.
The person for whom the investment is done can be the transferor or the person who receives the benefit of the investment, or the offshore entity, or the fund itself, because the investment manager will often be contracted by or on behalf of the fund rather than the investment. One can imagine a situation, particularly in a corporate structure, in which the investment manager could be connected with the offshore fund.
The Law Society believes that it would be difficult for a transaction to satisfy the independence element of subsection (6) of this schedule. It suggests that the real test should not be about the structure of the transaction, because that is likely to result in subsection (6) not applying in a huge range of circumstances. Instead, it suggests asking whether the transaction between investor and manager is at arm’s length. Will the Paymaster General comment on that? Because if the criterion is one of structure rather than an arm’s length test, the exemption may be redundant.

Philip Dunne: I should like to give an example to elaborate on that point. It would be helpful if the Paymaster General would clarify whether the provision is intended to catch investment managers who seed a hedge fund offshore. Somebody may set up a hedge fund based in the UK that seeks to have its centre of operations in a jurisdiction such as the Cayman Islands, or another offshore jurisdiction attractive to other foreign investors who are looking to invest in that fund and who would not be subject to UK taxation. To get the fund off the ground the individual—possibly a sole trader—could make an investment in a special-purpose vehicle that would be set up in an offshore jurisdiction. That might be classified as a connected trade, because there would be no third party and it might take some time for the individual to establish the business—it often takes months if not years to get such investment vehicles running. It surely cannot be intended that such a situation be caught.

Mark Hoban: My hon. Friend’s point leads me to a similar one made by the Institute of Chartered Accountants about setting up a new business. An individual resident in the UK may establish a foreign company to trade outside the UK—possibly in a country with higher corporation tax rates than the UK—and he may decide that it is commercially sound to provide finance or assets to the company on favourable terms from his own resources, because he may consider it worthwhile to subsidise his company to enable it to generate revenue. The institute is concerned that that situation might be caught.
Those situations concern different types of business, but the issue remains how to demonstrate the value of assets that have been transferred overseas, and whether they were transferred at a commercial rate, and in both situations there could be an impact on the business economics. A more equitable approach in both situations may therefore be to consider the commerciality of a transaction as a factor to be taken into account in determining whether it was more than incidentally designed for the purpose of avoiding tax liability.
Subsection (4) of the schedule concerns the imputation of tax advisers’ motives to their clients. It says:
“The intentions and purposes of any person who, whether or not for consideration,—
(a) designs or effects the relevant transactions or any of them, or
(b) provides advice in relation to the relevant transactions or any of them
are to be taken into account in determining the purposes for which those transactions or any of them were effected.”
I am concerned that a tax adviser may decide to structure a particular transaction in a way that minimises tax but the taxpayer might not be aware of that. The clause would mean that taxpayers, even if they did not know, ought to have borne in mind the fact that the tax adviser may have tried to structure the transaction in a particular way.
I suspect that the Paymaster General will say—as she did on an earlier clause when we were debating an amendment tabled by my hon. Friend the Member for Wycombe—that we are talking about legislation targeted at particular schemes that have been marketed to individuals in an aggressive fashion, and cases in which both the taxpayer and the adviser know the exact purpose of the scheme, which is to reduce tax. Could the Paymaster General comment a little further on subsection (4), and say whether she thinks thatthe terms have been drawn so widely that there may be situations in which innocent taxpayers—someone setting up a business overseas, for example—are inadvertently caught by that subsection?

Rob Marris: I do have some sympathy with thehon. Gentleman’s point, and I think that it has also been made by the Law Society of England and Wales, of which I am a member, but I caution him about picking up other people’s briefs, because I am almost certain from what he has read that he is referring to subsection (4) of proposed new section 741A, which is to be inserted into the Act. That is at the bottom of page 193. It is not a subsection (4) to the schedule. If I have got it wrong, and he is not referring to the final two lines on page 193 and the first lines on page 194, perhaps he will tell us so, but if he is referring to those lines, I caution him about the way in which he takes his briefs.

Andy Reed: There is no answer to that.

Mark Hoban: There is indeed no answer to that, and it is indeed proposed new section 741A that relates to subsection (4) on line 39, page 193. One of the issues in dealing with a Bill such as this one is that outside bodies are interested in it, and raise concerns about the scope of the changes and their impact on lawyers, accountants, taxpayers and so on.
The Law Society also has concerns about whether the provisions would allow inquiries into the purposes of the adviser, and it also raises issues around legal privilege and the confidentiality of clients’ information. I am not a member of the Law Society of England and Wales—and I am, at times, profoundly grateful for that. My hon. Friends and the hon. Member for Wolverhampton, South-West may wish to comment on that aspect of the Law Society’s brief, but that is a concern that it has, and it is important that the issues that it raises are aired on its behalf, as there are so few solicitors in this House who can speak up in its defence.
May I just comment on subsection (9) on page 194? It says:
“The jurisdiction of the Special Commissioners on any appeal includes jurisdiction to review any decision taken by an officer of the Board in exercise of the officer’s functions under this section.”
I should be grateful to hear from the Paymaster General whether that gives the special commissioners the power to amend or vary the decisions taken; I suspect that it probably does, but I should be grateful for that clarification.
I also want to raise the thorny issue of clearance, which has popped up in debates along the way. As I understand it, any application for exemption under section 741 is dealt with under a self-assessment system, so that a company entering into a transaction such as establishing a foreign company—something that my hon. Friend the Member for Ludlow (Mr. Dunne) referred to—would claim the exemption in its 2007 tax return. Assuming that the taxpayer were to submit his return before the 31 January 2008 deadline and full disclosure were made, HMRC would have until 31 January 2009 to open an inquiry into the tax return. In effect, the taxpayer would not know for certain whether he has a UK tax liability in respect of the company’s income until almost three years after the company was established. That will create uncertainty in the minds of taxpayers.
We discussed how exemptions could put into question some transactions. One solution that would deal with the uncertainty and provide a clearer picture for the taxpayer earlier than up to three years after he establishes the business would be a formal clearance procedure. An alternative is the informal route that the Paymaster General referred to under clause 78, whereby a taxpayer could seek guidance from HMRC which would then be binding.
I understand that advisers and professional bodies have been in discussion with HMRC about the issue and that at present the Government are not proposing a clearance system but are prepared to consider, in the light of further evidence, whether such assistance might be necessary. I understand that people are trying to determine whether there is sufficient evidence to justify taking the matter back to the Treasury. I should be grateful for the Paymaster General’s views on whether any informal clearance will be offered to people who wish to set up such transactions.
This is not a straightforward schedule—I have ploughed through it—and people outside this House are interested in following through some important issues around the extent of the exemptions. Theywant to ensure that bona fide, genuine commercial transactions will not inadvertently fall within the scope of the Bill, and they are particularly concerned about how conditions A and B and subsections (5) and (6) will operate.

Jeremy Wright: I have three concerns about what is proposed in subsection (4) of proposed new section 741A of the Income and Corporation Taxes Act 1988. As we have already discussed, the proposed new subsection deals with the intentions and purposes of the designers of transactions, and of tax advisers.
The first concern arises because of a potential difficulty with legal privilege. I should make it clear that I am a lawyer but not a member of the Law Society. It is right, of course, that some of the advisers that the schedule refers to will be tax lawyers—any member of the Gauke family, for example—and under such circumstances a difficulty with legal privilege may arise. I wonder whether the Paymaster General can comment on that.
The second difficulty is a practical one. Transactions will be permissible although they avoid tax liability if they were incidentally designed to avoid tax. It is difficult to envisage circumstances in which it will be possible clearly to establish how an adviser explained to his client that a particular transaction would only incidentally avoid tax, rather than primarily avoid it.
My hon. Friend the Member for Fareham referred to the third difficulty, which seems to be the key problem. Surely it is the intention of the taxpayer, not the adviser, that the Government are keen to explore. Those two things are not necessarily the same. It is right and logical that the client—the taxpayer—goes to an adviser because the adviser has more knowledge of such matters than the client does; otherwise, the advice would scarcely be necessary. It is therefore conceivable that the adviser understands far more about the avoidance of tax than the client does, and only if that intention to avoid tax is communicated to a client does a problem arise.

Dawn Primarolo: Is the hon. Gentleman seriously suggesting that if a professional adviser knowingly advises on tax avoidance and the client simply does not ask because they are happy to take the money, there is no responsibility?

Jeremy Wright: No. I am suggesting that a tax adviser might advise a client on a sensible measure to take to order his financial affairs, which that tax adviser understands far better than the client. If that measure were taken incidentally to avoid tax, it would be perfectly acceptable under the Government’s proposed legislation, but if it were taken primarily to avoid tax, it would not be. That distinction might in some circumstances cause clients difficulty.
The measures are entirely superfluous. If the Government are seeking to penalise those taxpayers who understand that they are avoiding tax, surely the taxpayer’s intention and not the tax adviser’s is significant. If a taxpayer came to understand from his tax adviser that what he was going to sign off on was tax avoidance, he would rightly be penalised for it. But why is it necessary to include in consideration the intention of the tax adviser rather than what he has communicated to his client? That seems to be the difficulty created by the clause.

Dawn Primarolo: Clause 79 and schedule 7 will amend legislation on the transfer of assets abroad. They are important anti-avoidance provisions that were enacted in 1936, an important date in our understanding of how the rules should operate.
The rules introduced in 1936 aimed to prevent UK-resident individuals from avoiding UK income tax by putting assets in offshore structures in such a way that they retain control of the income arising from those assets. The changes announced in the pre-Budget report closed a loophole exploited by tax planners to avoid tax.
The provisions in schedule 7 will recast the exemption test for post-PBR transactions. All relevant circumstances, including the objective outcome of the transaction, must be taken into account when deciding whether there was a tax avoidance purpose. The intention of advisers must also be considered. I shall return to that point.
The right hon. Member for North-West Hampshire asked whether the question of purpose and reasonableness was new. The straightforward answer is no. It is elsewhere in the legislation—in section 741 of the Income and Corporation Taxes Act 1988, for example. Will the proposed measures shift the balance toward HMRC? No. That is how HMRC operates currently.
Perhaps I should give a slightly longer answer. The provisions are based on the existing purpose test in section 741 of the 1998 Act. The Government’s view is that section 741A strikes a fair balance. Its aim is a reasonable conclusion test to ensure that all circumstances are taken into account when deciding whether an individual had avoidance purpose. It is right to take all relevant factors into account and draw a reasonable conclusion.
The courts and commissioners have full power to consider HMRC decisions and replace them if they decide that the taxpayer met the terms for exemption under the reasonableness test. There is no doubt that special commissioners’ jurisdiction under the provisions will necessarily include a power to vary or set aside HMRC’s decisions, not just to review them. That has always been the case under current legislation, which has virtually the same wording.
On the question of legal professional privilege, I disagree with the point that the hon. Member for Rugby and Kenilworth (Jeremy Wright) made. The aim of subsection (4) is to ensure that the professional advice obtained is taken into account as one of the circumstances of the case and not disregarded as irrelevant. If an individual asserts that they did not have the subjective purpose of avoiding tax, it is reasonable to see whether the advice they were acting on was consistent with that claim. That is all that is being required.
The new provision does not override advisers’ legal privilege. There is no compulsion under subsection (4) to disclose advice given to clients. However, in practice, using the example that the hon. Gentleman gave, it may be in the taxpayer’s interest if advisers do provide advice and waive that privilege, assuming that the advice given is consistent with the claim that there is no subjective purpose of avoiding tax. Otherwise, there is a complete mismatch; people would say, “I didn’t have the knowledge, they just happened to get a good deal for me.” That is ridiculous and that connection has to be made.
There is no reason why transactions involving innocent offshore structures, such as family trusts, could not qualify under condition A; likewise for ordinary investment transactions on arm’s length terms in commercially run offshore entities. In such cases, conditions for a section 739 charge might apply. However, the taxpayer could potentially show that an exemption was due.
The approach for condition B mirrors that of the old purpose test in section 741. It strikes a reasonable balance in allowing some element of avoidance in commercial cases, provided that they are no more than incidental, but that is an essential part of the test and the case must be genuinely commercial and not driven by tax avoidance.
I disagree with the idea that subsection (5) is too restrictive. It is needed to prevent the abuse of non-resident personal trusts for avoidance purposes by UK residents. Generally, in cases where individuals make ordinary investment transactions in entities independently managed by commercial concerns on arm’s length terms, condition A in section 741A will be satisfied. There may be exceptional cases in which it is appropriate to use section 739 against particular marketed retail investment projects.
I shall not even attempt to answer the point made by the hon. Member for Ludlow; what he says shows the complexity of the issues. Given that the legislation has been in place for rather a long time—over 70 years—it would be foolish to respond specifically to his point. I am sure that he would not expect me to, without the full facts before me, and a summary of what might happen to hedge funds is not sufficient. Nor—before the hon. Gentleman rises to repeat his question—shall I indulge in giving tax advice. I am not a solicitor. I am not an accountant. There is a vast Department called HMRC that provides that advice, and it is the appropriate point for advice.

Philip Dunne: Will the right hon. Lady give way?

Dawn Primarolo: No, I shall conclude my points; then the hon. Gentleman can make his.
On the guidance that HMRC could give on the operation of the legislation and in response to the issues raised by the hon. Gentleman, I should say that a drafting of guidance is in hand. HMRC aims to show that guidance to representative bodies so that the agreed version can be published at about the time of Royal Assent. The guidance will have examples of how the rules will work in a number of different cases.
The final point was about the pre-transaction clearance system. I shall make clear what is going on in discussions with HMRC. HMRC has already written to the representative bodies explaining Government decisions in respect of the schedule and why it thinks that a clearance is not necessary. Nevertheless, as one would expect, the Department has indicated a willingness to consider, without commitment, any further supporting evidence showing why a clearance system is necessary.
Section 739 has existed for 70 years without clearance. The changes under the Bill should make the law clearer and remove doubt about how the purpose test is intended to apply. There is now potentially less, not more, need for a clearance system. As I said, HMRC will provide guidance on the new provision. The representative bodies will need to get over a rather high hurdle, given that something that has existed for 70 years and did not need clearance apparently cannot be understood now and needs it. As I said, there is no commitment, but if those bodies come forward to say why the system should change, the Department will be prepared to consider that.

Jeremy Wright: Will the Paymaster General deal with my point about intention? I did not hear her deal with that. My point was that, on section 741A(4), I would entirely understand if the Government’s case was that it is important to know what advice a taxpayer has received in deciding whether that taxpayer intended to avoid tax. The difficulty is that subsection (4) does not say that; it deals with the “intentions and purposes” of the adviser, not the advice given.

Helen Goodman: I am interested in the hon. Gentleman’s argument. Will he try to reconcile this? Many of us have listened to the shadow Attorney-General use up hours of time on the Floor of the House discussing intention in respect of terrorism legislation. He said that maintaining intention in that legislation was vital.

Jeremy Wright: I shall try to assist the hon. Lady. I am worried not about the fact of intention, but whose intention we are talking about. I am talking about the intention of the taxpayer. When it comes to the avoidance of tax, the Government ought at the very least be concerned about whether the taxpayer intends to avoid tax. My concern is that, although I understand the logic of wanting to know what advice a taxpayer has received, I am not clear about why the legislation deals with the “intentions and purposes” of the adviser rather than with the advice given. I invite the Paymaster General to deal with that specific point.

Dawn Primarolo: I dealt with that point. I made it clear that if an individual asserted in their defence that they did not have the subjective purpose of avoiding tax—that their intention was not to avoid tax—the Government would not consider it unreasonable, if the specific avoidance that HMRC seeks to close off was indicated, to see whether the advice on which the individual was acting was consistent with that claim. This is a responsibility of the taxpayer.
Therefore, as I have said, I do not believe that any taxpayer would not understand their intention or the type of advice they had been given, or that their legal advice or professional advice in any other way would have left them ignorant of the purpose. This is another test to discover whether the claim made by a taxpayer is sustained by the professional advice that they then acted on—they signed forms, they acted on it.

Mark Hoban: I thank the Paymaster General for what she has said in response to the points I and my colleagues made on this schedule. She has set out clearly the Government’s position on a range of issues, and she has added some welcome clarity, particularly on the operations of condition A and condition B, for which we are grateful. Given that this legislation seems to have remained relatively untouched for 70 years, I would like to think that we will not revisit it in the next 70 years, but I fear that our hopes and aspirations of not doing so will be dashed as I am sure we will examine it again at some point in the future.
The Paymaster General referred to the ongoing consultations on the guidance. They are welcome, and the guidance should flesh out some issues; it might not go so far as to address Cayman Islands hedge funds, but I hope it might address matters such as businesses being set up overseas where a transfer of assets has taken place at less than commercial value with a view to setting up the business.
Finally, I am grateful for the confirmation that the power to review includes set aside and vary. The Paymaster General confirmed that in such a way that it seemed an obvious point, but it was not obvious to some of the people who have commented on this measure.

Question put and agreed to.

Schedule 7, as amended, agreed to.

Clause 80

Restriction of exemption from charge to income tax

Question proposed, That the clause stand part ofthe Bill.

Theresa Villiers: The Opposition have considerable sympathy with the Government’s efforts to target the particular type of reverter to settlor double trust arrangements that are the primary focus of the clause. However, we have certain reservations about the clause, which I should express in the context of our views on the pre-owned assets regime as a whole. If I take the Committee through a couple of those general points on the regime, I can then go on to deal with clause 80 with some rapidity.
As far back as 1986, rules have existed to prevent people from opting out of inheritance tax by transferring title to their homes to their adult children while continuing to live in them. These have been colloquially described to me by some experts as
“having your cake and eating it arrangements”.
From 1986 onwards, the gift-with-reservation rules looked through such transfers and treated the house as part of the estate of the parent on death for inheritance tax purposes; hence, a Conservative Government made the first move against such arrangements. Therefore, there is clearly a degree of common ground in all parts of the House in respect of seeking to prevent people from avoiding inheritance tax using this type of scheme.
However, the Government’s pre-owned assets rules, which were an addition to the gift-with-reservation rules and which came into effect in April 2005, have provoked considerable controversy and anxiety amongst those affected by them. As veterans of the Committee may recall, in both 2004 and 2005 the Opposition expressed serious concerns about the pre-owned assets regime on the grounds that there was a risk that it would lead to double taxation and that the rules were drafted in such a way as to penalise a number of innocent transactions between family members. In respect of the first point on double taxation the key anxiety was that the arrangements that had to be dismantled as a result of the new pre-owned asset rules might be hit with a double inheritance tax charge. I acknowledge that the Government have heeded the warnings given on the matter by the Opposition and professionals, and I am grateful that they have moved to deal with the double taxation problem via secondary legislation. However, it is worth drawing to the attention of the Paymaster General and the Committee the fact that there are serious concerns whether the regulations published in December can deal effectively with the problem. Taking into account the impact of schedule 20, the Government appear to have provided in the regulations a relief that nobody can use. I illustrate that as follows.
The most serious double taxation problem under the pre-owned assets regime concerned the so-called home loan schemes, which involved an IOU held by the second of the two trusts that made up the scheme. Members who were on the Committee last year will recall that more than 30,000 people have entered such schemes, so it was and remains a significant issue for many. To unravel such a scheme in order not to fall into the POA regime or go back into inheritance tax—the Paymaster General acknowledged that that was entirely in order, even desirable, for those who have entered a trust—the second trust must release the IOU, the debt that was part of the original avoidance schemes targeted by the POA legislation.
After various representations, the Paymaster General agreed that there was a problem of double taxation in such cases. The December regulations specifically provide that double charges relief will be available for inheritance tax purposes if the debt is released. The aim of the regulations was to ensure that if someone died within seven years of having entered a home loan scheme, the IHT charge would not be levied on the same economic value twice.
The problem occurs as a result of schedule 20 to the Bill. If the schedule is accepted unamended—I hope that it will not be—it will treat the release of the debt as an addition to the trust and an immediate 20 per cent. inheritance tax charge will be levied if the debt exceeds the inheritance tax nil rate band, which I am told it will in many cases. So people are getting relief from one inheritance tax charge as a result of the Paymaster General’s welcome December regulations, but it seems that they run into another because of schedule 20. We must bear in mind that many people did not unwind their schemes before the Budget because they had been waiting for the double charges regulations that came out in late December, and not all their arrangements and paperwork had been completed by March.
It would be welcome if the Paymaster General were prepared to look into the matter to see whether schedule 20 will have the impact that I have described. It seems odd that, having issued regulations to prevent double charging as a result of the release of the debt in a home loan scheme, the Treasury now seeks to impose an additional charge on the release of that debt. I hope that, having stated clearly that double taxation should not occur in the cases in question, the Paymaster General might consider amending either schedule 20 or the December regulations to ensure that they have the effect that I believe she wants.
The Opposition’s second reservation with the pre-owned assets rules is that there are a number of situations in which the ownership of property is transferred between family members without tax being the motivation. Those transfers could be caught by the pre-owned asset rules, which were so widely drafted as to cover all disposals of land and could therefore penalise such innocent transactions. Examples that have been brought to my attention include a situation in which one cohabitant gives money to her partner, who uses it to pay for the purchase of the house in which they both live. Even if they later marry, the donor cohabitant is caught by the pre-owned assets charge. Cohabitants would be well advised to re-examine all such transactions as far back as 1986, in case there is a danger of an unexpected pre-owned assets charge.
I acknowledge the Revenue’s willingness to move on the matter when representations have been made to it in the past to try to exclude such innocent transactions, but problems remain. A particular difficulty is caused if family members make arrangements that fall foul of the rules without having any idea of the tax consequences. They might require the informal arrangements that do not involve taking specialist tax advice on the pre-owned assets regime.
In an age in which pensioners are increasingly asset rich and cash poor, we must bear in mind that their children might well want to help them to realise some of their wealth by buying a share of the equity in their parents’ homes. If such arrangements are entered into by a parent and a bank, there is no problem, but if that kind of equity-release arrangement is set up between family members, it triggers the POAT rules. It does not matter if the sale was at a commercial price, because the pre-owned asset tax still applies on the cash element, even if it will attract inheritance tax on the parent's death.
If the Government wish to stop people from giving away cash raised by equity release, they could easily provide for that. It seems odd that where two members of a family live together and one gives the other a share in the house, the donor is not caught by the reservation of benefit rules or the POAT rules. However, if the donor has insufficient resources to make the gift and instead sells the interest to the other person living there, whether or not at full value, the transaction is subject to the pre-owned asset rules. Those are our reservations about the framework as a whole.
I turn to the clause itself. I can see why the Revenue would want to target the double trust reverter to settlor trusts that are the focus of clause 80, as such schemes were clearly aimed at getting around the IHT rules. I certainly prefer the more targeted approach in the clause to the broad-ranging attack in schedule 20 on a whole range of trusts, most of which have nothing to do with tax. As I made plain in my opening for the official Opposition on Second Reading, we are prepared to work constructively with the Government in their efforts to target artificial schemes that may use trusts to avoid tax, as long as the legislation is specifically targeted on such artificial schemes.
The majority of trusts hit by the clause seem to fall into that category, so we approach it with a degree of sympathy, but we have some concerns. First, the clause has a retrospective effect in that it applies to existing arrangements. That point is not as serious in this case as it is in relation to schedule 20, because one would think that those entering into such schemes probably had an idea that they were likely to attract the attention of the Revenue at some point. None the less, it is still a concern that this will be one of a number of occasions on which the Government have introduced legislation that is, in effect, retrospective.
Our second and more serious concern is about the scope of the provision. As with the overall pre-owned asset regime structure, there seems to be at least some evidence that the width of the drafting could catch some innocent transactions. I would be grateful if the Paymaster General considered the point made by the Institute of Chartered Accountants, which states:
“The mischief at which the clause is aimed is where property is part of an individual’s estate as a result of section 49 IHTA 1984 but will revert to a settlor when that interest comes to an end on death.”
The institute goes on to recommend that the clause should be more specifically aimed because it currently denies
“the benefit of the relief where an individual has the relevant property in his estate even where the revertor to settlor exemption is not available.”
The Chartered Institute of Taxation has expressed similar concerns. Having spoken to its representatives, I know that, in essence, its worry is as follows. Let us take an example in which H sets up a trust for his wife for life, into which he puts an interest in a house. He might have done that some years ago—perhaps in the late 1980s—for various reasons, some of which might involve tax and some of which might not. It might have been part of an arrangement to make provision for the wife as part of a matrimonial settlement. So, the wife initially has an interest in possession. Subsequently, she dies and the property reverts back to H. No IHT would be payable at that point because of the spouse exemption. H takes a qualifying interest in possession and the property is part of his estate for the purposes of section 49 of the Inheritance Tax Act 1984. On his death, IHT would be payable in the normal way, because there is no double trust arrangement that gives rise to the reverter to settlor exemption in section 54.
The settlement was set up by H and no one else, so no loophole is being used. In essence, the value of the house is subject to normal inheritance tax charges. However, under clause 80, H would, from 5 December, be liable to the pre-owned assets tax, because the new paragraph 11(11) to schedule 15 of the FinanceAct 2004 has been breached. This property was once part of his estate and he now has an interest in possession in it again. The net result of this rather complicated arrangement is that both the pre-owned assets regime and inheritance tax apply and we have a double taxation situation.
I do not have enough empirical knowledge to know how common these trusts might be, but I hope that the Paymaster General will agree to look at this area as it is clearly not the Government’s intention to inflict both the pre-owned assets tax and inheritance tax on the same arrangement. I hope that the Government will consider amending the clause or looking at it again to ensure that it targets only the double trust reverterto settler arrangements, which are specifically designed to exploit the loophole in section 54, and not the type of situations that I have described. Certainly as the Chartered Institute of Taxation points out, the scope of the clause seems to go rather beyond the press release in the Budget report. Perhaps it would be possible to tighten up the drafting in order to ensure that it focuses on the artificial schemes that I believe the Paymaster General has in mind.

John Butterfill: At this point, may I say to hon. Members that I hope that this will not turn into a debate on schedule 20? It would be rather premature to have that debate.

Dawn Primarolo: Indeed, Sir John. I should point out to the hon. Lady that, whatever she might think, the changes contained in the clause are completely unrelated to the issue she referred to. This is a free-standing clause directed at artificial trust arrangements that are designed to get round both IHT gift with reservation rules and the pre-owned asset income tax charge. The problem when professional bodies write complex examples is that it is difficult to know whether they are giving real examples or are seeking to punch a hole in the legislation by describing a theoretical position. I have seen little evidence that her examples refer to common behaviour.
Let us take the example of the person who provided cash so that his mother could buy a house. The mother dies and leaves the house, interest and possession to her son who is then caught by the income tax charge. Let us look at how unlikely that would be. It would require the person in question to make a significant gift to somebody else to purchase an asset, only to have it resettled upon them under the person’s will within seven years and then take up occupation and receive an imputed benefit of more than the de minimis limit of £5,000 per annum. The amendments that we have made to the election provision would enable the person to elect out of the income tax charge. The relationships that have been suggested seem somewhat unlikely, but even so the answer is for the person to elect out of the income tax charge if their interest also forms part of their estate for IHT purposes.
The hon. Lady gave a further example and I am aware that representations have been made to the HMRC about it. It is in connection with elderly parents being caught if they do not have enough property to be liable for IHT. They sell their house and give money to their children to convert part of their house into a granny flat. I believe that that was discussed during the debates on pre-owned assets. I have asked the HMRC, under those circumstances, to monitor the situation so that we can see whether that is an issue and whether it will create difficulties with the pre-owned assets. Should that be the case, I would be prepared to reconsider the matter.
I remind the Committee, however, that the pre-owned asset rules are targeted at those who use contrived structures to avoid paying inheritance tax—that still stands. I was amazed at some of the examples in defence of the individuals who claimed that they were not trying to avoid inheritance tax. Often that paves the way to a clear indication that that is exactly what they were trying to do.
The hon. Lady also said that innocent cases could be caught by the provisions. With the exception of the case that I flagged up in which there is discussion with representative bodies and which I am asking the HMRC to monitor carefully—the legislation was not intended to apply to such a case—the truth is that it is incredibly unlikely—it still has not been asserted—that innocent cases will be affected by the pre-owned assets regulations, even in the cases that she mentioned.
Great care is always necessary in such matters, but the fact is that the reason for the exemptions, and hence for the clause, is to ensure that individuals do not sidestep income tax or the IHT charges and do not avoid income tax charged to the pre-owned assets or the inheritance tax. I see you smiling, Sir John, but given the arguments that were advanced in the introduction of the pre-owned assets, I am sure that you understand that I am not particularly attracted to such action.
I am sure that we will have a lot of time to discuss the matter during consideration of later clauses, but I can assure the hon. Lady that care is taken over the interaction of the legislation. If she is seeking an assurance from me that I shall continue to do that in the course of this Finance Bill, I can give her that assurance. However, perhaps some of the points that she made today would be more appropriately explored at a later stage.

Theresa Villiers: I acknowledge that that issue is separate from schedule 20, which is why I did not seek to advance issues on schedule 20 apart from where I felt that there might be a difficulty with its interaction with some of the pre-owned asset regimes. I refute the suggestion that I was seeking to punch a hole in the legislation. I made it plain that I was not seeking to defend the double trusts reverter to settlor arrangements.

Dawn Primarolo: I was not suggesting for a minute that the hon. Lady was seeking to punch a hole in the legislation. If I thought that that was the case, I would have been much clearer and said it to her directly. I was referring to the examples constructed, which often inadvertently have that effect. So unless she dreamed them up herself, I am not accusing her of such a thing.

Theresa Villiers: Turning to those examples, I think that the Paymaster General referred to one given by the professional bodies to which I do not think that I referred. I did not refer to any of the examples in which a parent passed a property to a child and the child then sets up a trust. I referred to one example in which an individual sets up a trust for his spouse. Again, I emphasise that I acknowledge that there are significant problems when a property is transferred to a child and a trust is set up. They seem to be at the heart of the double trust situations, which the clause is targeting. As I have said on several occasions, I can understand why the Government want to target them. The situation that I described is subtly different. There is no double trust and no attempt to exploit the loophole that is provided by section 54. That can be done by setting up a double trust. It would be useful for the Paymaster General to bear that in mind.
Lastly, I welcome the Paymaster General’s indication that she is prepared to monitor situations where, for example, an elderly parent sells a share in the equity of their home. As I said, she and the Revenue have shown a welcome degree of flexibility in trying to remove innocent transactions from the scope of these proceedings. I know that there was a particular concern about loans between family members triggering the pre-owned assets regime. I gather that, through extra statutory mechanisms, it looks like that anxiety is being averted. I am pleased to hear that that approach, which tries to ensure that innocent transactions stay out of a very penal pre-owned asset regime, is continuing in relation to some of the examples that I mentioned.
I sign off by saying that, in the complicated example I raised, the real problem was the double taxation charge. Regardless of what one thinks about the motivation for setting up a trust, I hope that the Paymaster General would agree that one of the things we do not want to come out of this measure is that people end up in the pre-owned assets regime and pay inheritance tax. It should be one or the other.

Question put and agreed to.

Clause 80 ordered to stand part of the Bill.
Further consideration adjourned.—[Mr. Andy Reed.]

Adjourned at twelve minutes to Seven o’clock till Thursday 25 May at five minutes past Nine o’clock.